The perils of surplus capacity

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Published: November 11, 2014 12:33:47 AM

The issue of excess capacity is being cited as one of the primary reasons behind the downward trend in commodity prices.

The issue of excess capacity is being cited as one of the primary reasons behind the downward trend in commodity prices. For crude oil, the OPEC group is restraining production to match it with falling demand. For many other products, specifically for products requiring extraction and exploration, the challenge of surplus capacity is taken care of by cutting down output. The same strategy is being pursued by BHP Billiton, Vale, Rio Tinto, Frotesque and coal miners of the US, Australia, Mozambique, South Africa and Indonesia.

The resources stay put under the ground, if not explored. For some other products, export thrusts may be a temporary way out, but looking at the subdued demand scenario all over the globe, this strategy may provide a temporary solution with reduced margin only.

According to latest WSD estimates, around 145 million tonne of finished steel is lying surplus in China after meeting domestic demand. It is not difficult to assume that in Japan, Russia and South Korea, the other major steel producing countries, surplus capacity is plaguing all and it has forced these countries to look for other destinations to sell their products.

In 2013, exports from these countries along with China formed nearly 40% of total global exports of finished steel. In some major products where China carries excess capacity, like rebars (estimated surplus capacity: 18 mt), wire rods (40 mt), HR coils (15 mt), galvanised/coated products (23 mt) and plates (30 mt), it has emerged as the major exporter to India.

In H1 of FY15, the Chinese share in total imports by India is: rebars/wire rods (63%), plates (45%), coated products (20%) and HR coils (29%). The surplus capacity in HR and CR in Japan and South Korea is shifted to India with 60% import share in HR, 59% share in CR and 79% share in coated/GP products.

It can be safely concluded that one of the objectives of FTAs and RCEPAs is to find a market for the surplus capacity that is creating job and income losses and poor capacity utilisation in some of these countries which are otherwise clamouring for fair and unrestricted trade.

The problem of excess capacity is in reality compounded in steel as production cuts enhance the fixed cost component of production apart from other technological problems associated with not running furnaces below the capacity for a longer duration.

In developed economies, the share of steel service centres that provide customised, tailor-made sizes, cut-to-length dimensions and shapes is more than 25% of total production. The inventory build-up by the centres to cater to the regular needs of the various processing industries provides an additional outlet for surplus steel.

India is way behind in realising the full potential of this phenomenon and instead many global producers like Posco, Arcelor Mittal, Corus and Nippon-Mitshubishi have created world class facilities in India, thanks to land and environment related issues that have kept them away from greenfield ventures.

Following the passing of MM&DR, allocation of coal blocks and initiation of demand boosting stimulus measures like investment in infrastructure and manufacturing growth in the country, all efforts by indigenous steel producers towards cost competitiveness and thrust on value-added products would continue to face stiff challenges from the steady flow of imports under concessional duties from countries weighed down under surplus capacity.

The author is DG, Institute of Steel Growth and Development. The views expressed are personal

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